The back story to Citizens Bank's $14 million overdraft settlements

Citizens Bank and its parent, RBS Citizens of Providence, R.I., itself a subsidiary of Royal Bank of Scotland Group, aren't saying saying why they agreed to pay about $14 million to settle overdraft complaints from federal regulators, as reported today by my colleague Harold Brubaker.

A spokeswoman told the Inquirer that Citizens has "changed the practices identified in these exam results and are working with our regulators to address any customer impacts that they have identified." But it's fair to note that the bank's overdraft practices have repeatedly drawn criticism - as have similar practices at most of the nation's leading banks.

In 2011, for instance, the Consumer Federation of America crunched the numbers to see how much it would cost a consumer to carry an overdraft for two weeks - essentially as an unlabeled loan - at each of 14 leading banks. As I wrote back then, CFA's analysis found Citizens Bank leading the list:

If you're a Citizens customer and write a $100 overdraft check, within two weeks you'll owe an additional $106.90 to the bank - a $37 overdraft fee, plus an extra $6.99 per day in "sustained overdraft" fees for the fourth through the 13th day. Represented as an annualized interest rate, or APR, that's the equivalent of a 2,779 percent loan. (Yes, that's a comma, not a decimal point.) One small saving grace: You'd save a little if it was your first mistake - Citizens' initial fee for that is $22.

Some other banks' fee structures were better, but still costly to anyone who uses overdraft protection to cover cash-flow shortfalls. The best of the bunch was Citibank, which charges a $34 for the initial infraction and no sustained-overdraft fees. But paying $34 for a two-week loan of $100 is still the equivalent of paying 884 percent, CFA says.

In a similar analysis last year, CFA found that RBS Citizens charged the same amount, topped only by the effective 3,250 effective APR charged by Fifth Third Bank - whose rate was about to drop because of its scheduled elimination of its own sustained-overdraft fee.

The Consumer Financial Protection Bureau has authority to rein in overdraft fees that go far beyond the actual cost of the service to banks - evidence that belies a common bank argument that overdrafts are a courtesy and not intended as loan products. A new report by attorney Chi Chi Wu at the National Consumer Law Center argues that the CFPB should do just that, and recounts the history of a process - banks' fronting money to their customers via checking accounts - that quietly morphed from an occasional service to good customers into an unlabeled credit product:

Traditionally, banks usually denied transactions when the consumer’s account contained insufficient funds. They permitted overdrafts usually only for their best customers as an occasional courtesy.

However, with the advent of computer software programs, and the arrival of third‐party vendors that sold services to help banks maximize fee income, banks realized they could generate large profits by permitting and even inducing overdrafts. For consumers who have regular income coming into the account, especially if the income is direct deposited, the bank is guaranteed a payment that will repay the overdraft and the accompanying fees in a matter of days. Thus, the last ten to fifteen years have seen the rise of automated overdraft programs that impose enormous costs on consumers and generate large profits for banks.

It was the third‐party vendors that initially catalyzed current overdraft practices by selling programs that would automate overdrafts, as well as creating tactics to maximize them. In the early 2000s, these vendors promoted these programs to banks by claiming they would allow banks to significantly increase their overdraft fee income. For example, the website of one consultant (Pinnacle) promised banks that its services would raise overdraft fee income by “100%, 200%, 300% or more!” A pioneer in this field, John M. Floyd Associates, claimed that financial institutions participating in its program would increase overdraft income anywhere from 50 to 300%.

According to the American Banker, yesterday's settlements between RBS Citizens and two other bank regulators,  the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, require the bank to pay nearly $4 million in restitution to customers - 265,000 under the OCC settlement, and 75,000 under the bank's agreement with the FDIC.

The Banker's report said:

"The FDIC determined that" Citizens "engaged in deceptive practices in violation" of the Federal Trade Commission Act "in the marketing and implementation of its overdraft payment program, checking rewards programs and stop-payment process for preauthorized recurring electronic funds transfer," the agency said....

Among the OCC's findings were that RBS Citizens employees had, prior to August 15, 2010, indicated customers could opt out of the bank's standard overdraft program but did not make clear to them that there were certain technical obstacles to the opt-out preventing fees in all cases. As a result, some customers who had opted out were still charged for certain transactions.

RBS Citizens, the OCC added, had also warned customers they could be charged fees when the bank — able to identify a low checking account balance — chose to pay off items or return checks to the customer so the account would not be overdrawn. But such fees were not charged in certain cases.

Other offenses included overdraft fees charged on transactions even when a customer could cover a portion of the overdraft from a savings account, fees charged for electronic funds transactions after a customer had requested that such transactions cease and misleading disclosures associated with rebates the bank promised through a checking rewards program.

Since the violations, new Federal Reserve rules have required banks to ask customers beforehand if they want their bank to cover debit-card overdrafts, despite the costs. But the basic problem remains, and goes well beyond yesterday's settlements with Citizens, which admitted no wrongdoing under the deals.

The banks can't have it both ways. If overdrafts are a non-credit product, then fees should be reasonably related to the actual harm a bank suffers if it inadvertently pays against an account with insufficient funds, as the NCLC report argues. If they are credit products, then they should be covered by Truth in Lending Act rules.